Are you planning to buy rental property, make tons of money, then quit your job?
That’s a good idea… and I want to encourage you but…
You first need to know some hard truths. It’s taboo to discuss these “truths” but here goes…
I bought my first rental in 1996 and have been addicted ever since. Rentals have helped my family pay off student loans, helped us become debt free (except for mortgages), and funded college savings. I am grateful. And I feel blessed.
However, I also feel a growing pressure to say some unflattering things and offer some suggestions, too.
Things Seasoned Landlords Don’t Admit
I really struggled writing this. Mostly because I have to admit that I’ve been duped.
Things aren’t completely as they seem.
But looking back over 20 years, the highs and the lows, the windfalls and losses, I offer you these insights. These are the words I wished someone would have shared with me:
1 – Quantity doesn’t matter – net income does
It never fails. If I’m at a networking event someone will ask, “How many rentals do you own?”
It’s a way to gauge my experience and qualify me for future business opportunities. I get it, no harm – no foul.
It’s just that the question is so misguided. After all, we aren’t farmers growing corn. These are dwellings not acres of land. The number of doors I own only indicates how large my business is, not how profitable it is. Huge difference.
From experience, let me confess that having a lot of rentals won’t make you feel rich. That’s because most of the time whatever cash comes in eventually flow back out. And that’s normally the case when you have a typical 80% Loan-to-Value (LTV) mortgage and only peruse market rents.
It’s very possible to have 10 or 20 rentals with a 1:1 income-to-expense ratio and end up with a $0 net income for the year.
If you’re truly maintaining your rentals, then breaking even before taxes is the norm – you’ve done well.
2 – Striving for passivity postpones your payoff
Ahhh…the glamour of passive income… it’s so very sexy.
It’s the thing late night TV thrives on. And I’ll admit that I’m drawn to those images myself.
Yes, that lifestyle is attainable, but it’s something that occurs towards the middle of your investing career, not at the beginning.
And yes, you can hire everything out, and turn over nearly everything to a property manager, but that will dramatically cut into your net income.
Going passive is a solid plan if you just want to park and preserve your money. But if you’re trying to grow your wealth, the way of a passive landlording is not the way to go. The inefficiencies eat up your gains and postpone the day when you can become more passive.
3 – Market rents + big mortgages lead to decline
If you want to buy a rental, you’ll naturally make that decision based on current market rents. However, if you take an 80% LTV mortgage, by default you’ve set yourself up to own a 1:1 rental. And this goes for no-money-down deals as well.
If you aim for market rent income, you’ll be able to stay afloat but there won’t be much cash left over.
Your rental won’t be able to do the two things you want the most: support itself AND give you spending money.
Because of this, there will be a showdown between you and your rental’s reserve fund. Who will get first dibs at what cash flow there is?
Who gets fed and who will starve?
Typically, the reserve fund loses, and rentals get neglected. Good tenants leave and “good-enough” ones move in. Good-enough tenants won’t care for your place and you can barely afford the annual upkeep yourself… and so it goes.
It’s a cycle of decline.
But there’s an upside
Market rents are the common thread with all of these scenarios.
But you don’t have to accept it. And that is your opportunity.
You don’t have to limit yourself to long-term status quo market rents. You can re-position your rental and break out of the 1:1 box. You’re the owner; you get to decide.
That’s the opportunity before you. Pursue a course away from Craigslist tenants; serve a more profitable niche. But help is on the way…be sure to subscribe so you don’t miss the upcoming series.
Is the 1:1 cash flow-to-expense ratio working for you
Let me know if you disagree with the above. Did I mischaracterize the situation?
Also tell me if you’ve ever re-positioned a rental so that more flows in that goes out. I’d love to hear about it. Leave a comment below.